As Economy Slows, China Looks For A New Model

China's rapid expansion has been fueled in part by massive construction projects, like this one in Beijing, shown last year. But many economists say the Chinese economic model is unlikely to produce the same explosive growth in the coming years and needs to be revamped.

China faces overcapacity in various industries, including steel. This steel mill in the northern city of Tangshan went bankrupt in August after it expanded too quickly and the boss ending up owing banks more than $120 million. Authorities sealed the front gate with bricks.

China's government has poured a fortune into infrastructure in part to boost GDP. Not all the money is well-spent. This pedestrian bridge in the Southern boomtown of Shenzhen cost more than $8 million. Less than two years old, it already requires repairs.

Eight bridges have collapsed around China since 2011. Here, government investigators examine a recently built entrance ramp that collapsed this summer in the northeastern city of Harbin, killing three people. Local residents believe government corruption and substandard materials are to blame.

Frank LangfittNPR

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Originally published on November 2, 2012 11:06 am

If you followed American media in recent years, you might have thought China was taking over the planet. Recent titles at the book store have included Becoming China's Bitch and When China Rules the World.

"They are the world's superpower or soon will be," Glenn Beck used to intone on Fox News. "They always thought America was just a blip."

And when the city of Philadelphia postponed an Eagles football game a couple of years ago because of a blizzard forecast, then-Gov. Ed Rendell said America — unlike China — was becoming a nation of "wussies."

"If this was in China do you think the Chinese would have called off the game?" Rendell asked. "People would have been marching down to the stadium, they would have walked and they would have been doing calculus on the way down."

But China always looks more impressive from afar than it does close up.

The government in Beijing is targeting the economy to grow at 7.5 percent this year – well below the nearly 10.5 percent average growth of the previous decade.

Ask Chinese economists about the future of the world's second-largest economy and the tone these days is uncertain and anxious.

"I'm not as optimistic as many people in the Western world think about China," says Xu Dingbo, associate dean of the China Europe International Business School in Beijing.

"If you want to be the world leader, I think China is far from ready," adds Wang Jianmao, his fellow business school professor.

Andy Xie, a Shanghai-based economist, is even more downbeat.

"The efficiency is going down," he says. "Corruption is widespread. So I think this is the crossroads for China."

The Equation Changes

Why do these men sound so somber after so many years of spectacular growth here? The reason is that the economic formula that brought China such success no longer works.

Consider: Rising labor costs mean China isn't a cheap place to make low-end products anymore. Many low-skill manufacturers are either moving to China's interior or to countries like Vietnam to reduce costs. The financial crises in the U.S. and Europe also mean there are far fewer consumers to buy China's stuff anyway.

"The growth model has to change," says Nicholas Lardy, who is a senior fellow at the Peterson Institute for International Economics in Washington, D.C., and has studied China's economy since the 1970s. "They've done very well emphasizing exports and investments, particularly property for the last 10 years, but that string has run out."

Another big problem: China's economic growth is out of whack and unsustainable. About half of it is driven by investment, often in things like real estate and government infrastructure.

"The perceptions in the United States are based on the headlines, that China's been growing at double-digit rates for 30 years," says Lardy. "So we tend to portray China as a giant. It's very difficult from a distance to see the kind of structural weaknesses that exist here."

Signs Of Weakness

Today, you can see those structural weaknesses in places like Tangshan, a city of more than 7 million in north China where the steel industry is struggling. A cook named Liu has seen the problems close up. In August, steel mills on either side of his restaurant shut down.

"Because steel prices have fallen, workers are working less, about 15 to 20 days a month," says Liu as he fries up pork and onion pancakes on a sizzling skillet. "Compared with before, the number of customers has shrunk 50 percent."

One of the companies went bankrupt after it expanded too quickly. Workers told China's state-run press the boss owed banks more than $120 million. Local authorities sealed the mill's front gate with a wall of bricks topped with shards of glass.

In fact, by the end of last year, steel firms owed some $400 billion, according to the China Iron and Steel Association.

Economists say the problem is companies have overinvested in steel to feed an overpriced housing market and massive construction of government infrastructure. A steel mill official named Wang said his plant closed for more than three months this summer.

"I was worried when we would start back up again," said Wang. "Due to the effects of the market, about 20 percent of small-sized mills temporarily stopped production."

Wang didn't want his full name published because the problems in Tangshan's steel business are a sensitive topic. When I approached a coal depot to ask about demand from steel mills, an official there said it was a "state secret." He wasn't smiling.

Wang Jianmao of the China Europe International Business School says some companies keep producing and producing as though China's boom will never end.

"Because of the huge success of the past three decades, I have to say, made some Chinese people very arrogant," says Wang. "They take this fast growth just for granted. They don't believe China will have a crisis. The problem is: If you don't believe you will have a crisis, you will have a crisis."

Crumbling Bridges

The government has helped boost economic growth by spending a fortune on infrastructure. Much of it is needed, but sometimes money is poorly spent or siphoned off. Since 2011, eight bridges have collapsed around the country, according to China's state-run media. Most analysts blame government corruption.

One bridge in the southern boomtown of Shenzhen is a marvel of lavish spending and poor construction. The Spring Flower overpass is an $8 million-plus pedestrian walkway modeled on the Bird's Nest stadium from the 2008 Beijing Olympics all the way down to the metal latticework.

Less than two years after its completion, workers are drilling away, replacing the floor tiles because the bridge surface floods when it rains.

"It feels a bit extravagant, a bit wasteful," says an IT worker named Wu, who uses the bridge every day. "Money should be spent on where it's needed, not just on an overpass."

Given the shoddy construction and high price tag, Wu assumes the culprit is "inspectors [who] probably didn't do their work and builders who skimped on the job."

As to the $8 million? "They may have spent at most $1 to $3 million here," he says.

For Small Businesses, Loans Are Hard To Find

China's state-owned banks often fund these projects. But if you are a small or midsized private business — the kind that produces most of the jobs in China — getting a bank loan is very tough.

Ask Katrina Tong. She exports electric chargers for a company in Shenzhen.

"We think market demand for our products is out there and we have potential, but it's really hard to get financial support," says Tong, sitting at her desk in an office buried in one of Shenzhen's factory districts. "It is so frustrating. Investment all goes to big companies."

In fact, the vast majority of small and midsized companies in Shenzhen can't get bank loans. Instead, many turn to private lenders, who typically charge interest rates of 25 percent.

China's state-owned banks prefer state-owned companies, because they're less risky and also because, in a state-driven, capitalist economy, they have been expected to help government businesses.

Large Companies, Low Returns

But economist Xu says many state firms are woefully inefficient.

"You see lots of nice buildings, highways, beautiful cities like Beijing and Shanghai," says Xu, "but if you look at the real financial numbers of many Chinese companies, the picture is very bad. It's horrible."

Xu says the largest 102 state-owned companies had an average return based on assets of about 3.5 percent.

"For nearly half of the assets in China, the rate of return is less than depositing money in a bank," he says. "That means we are wasting lots of resources in China now."

Even as economists worry about the country's future, its leaders strike a tone that is at once optimistic and defensive.

"I do not agree with the argument that China's growth has come to an end after 30 years of reform," Wen Jiabao, China's outgoing premier, told an audience in September at the World Economic Forum in the port city of Tianjin.

Wen insists China can rebalance its economy away from heavy investment in real estate and infrastructure toward one that relies more on by China's 1.3 billion consumers.

"China is a country with enormous potential and a big domestic market and we the Chinese people have full confidence in our own development," Wen said.

Fixing China's economy will require taking on powerful interests, including the state banks and state-owned companies that enjoy monopolies and have thrived under the old economic model.

Analysts say transforming the economy is easily the biggest challenge China's leaders have faced in at least a decade and a half. But given the Communist Party's track record, no one is counting it out.

Copyright 2013 NPR. To see more, visit http://www.npr.org/.

Transcript

AUDIE CORNISH, HOST:

From NPR News, this is ALL THINGS CONSIDERED. I'm Audie Cornish.

ROBERT SIEGEL, HOST:

And I'm Robert Siegel. This week, we're looking at the challenges facing a new generation of leaders preparing to take over China's Communist Party. Over the last decade, the country's economy has exploded, becoming the world's second largest. But growth is now slowing and problems are mounting. As NPR's Frank Langfitt reports, China's incoming leaders will have to make tough reforms to keep the economy on track and their party in power.

FRANK LANGFITT, BYLINE: If you watched American TV in recent years, you might have thought China was about to take over the planet.

(SOUNDBITE OF ARCHIVED AUDIO)

GLENN BECK: They are now the world's super power or soon will be. (Applause)

ROB RIGGLE: China is definitely going to take over the world. But just how benevolent will our future overlords be?

UNIDENTIFIED MAN: "Becoming China's Bitch."

LANGFITT: But talk to Chinese economists these days. It's a different story.

XU DINGBO: I'm not as optimistic as many people in the Western world thinks about China.

WANG JIANMAO: If you want to be the world leader, you know, I think that China is far from ready.

ANDY XIE: The efficiency is going down. Corruption is widespread. So I think that this is the crossroads for China.

LANGFITT: That's Xu Dingbo and Wang Jianmao, both professors at the China Europe International Business School, and Andy Xie, a Shanghai-based economist. Why do they sound so somber? Well, the economic formula that brought China such staggering success doesn't work anymore. Nick Lardy is a senior fellow at the Peterson Institute for International Economics in Washington, D.C.

NICK LARDY: The growth model has to change. They've done very well emphasizing exports and investments, and particularly property for 10 years or so, but that string basically has run out.

LANGFITT: Rising labor costs means China isn't a cheap place to make low-end products anymore. The financial crises in the U.S. and Europe mean there are far fewer consumers to buy China's stuff anyway. And China's economic growth is out of whack. About half of it is driven by investment, often in things like real estate and government infrastructure. Again, Nick Lardy.

LARDY: The perception in the United States is based on the headlines that China has been growing at double-digit rates for 30 years. So we tend to portray China as a giant. It's very difficult to see from a distance kind of structural weaknesses that exist here.

LANGFITT: You can see those weaknesses in Tangshan. It's a city of more than 7 million in North China, and its signature steel industry is struggling. A cook named Liu is frying up pork and onion pancakes for steel workers. In August, though, steel mills on either side of his restaurant collapsed.

LIU: (Through Translator) Because steel prices have fallen, workers are working less, about 15 to 20 days a month. Compared with before, the number of customers has shrunk 50 percent.

LANGFITT: One company went bankrupt after it expanded too quickly. Workers told China's state-run press the boss owed banks more than $120 million. In fact, by the end of last year, Chinese steel firms owed some $400 billion, according to an industry association. Economists say the problem is this: companies have overinvested in steel to feed an overpriced housing market and massive construction of government infrastructure. One steel mill official named Wang said his plant closed for more than three months this summer.

WANG: (Through Translator) I was worried when we would start back up again. Due to the effects of the market, about 20 percent of small-sized mills had temporarily stopped production.

LANGFITT: Wang Jianmao of the China Europe Business School says some companies act as if the boom will never end.

JIANMAO: A huge success in the past three decades, actually, made some Chinese people actually very, I have to say, you know, arrogant. They think, you know, they take this fast growth just for granted. They don't believe, you know, China will have a crisis. But the problem - if you don't believe you have a crisis, you will have a crisis.

LANGFITT: The government poured tons of money into infrastructure, in part, to boost GDP - money not always well spent. To give you an example, right now, I'm in the southern boomtown of Shenzhen, and I'm standing on a pedestrian overpass. It's very elaborate. It actually looks like the Bird's Nest stadium in Beijing, costs more than $8 million to build last year. The problem is it wasn't very well-built, and when it rains, it floods. So right now, as you can hear in the background, people are drilling away, putting in new floor tiles. An IT worker named Wu uses the bridge every day. But he's critical of the project.

WU: (Through Translator) It feels a bit extravagant, a bit wasteful. Money should be spent on where it's needed, not just on an overpass.

LANGFITT: Given the bridge's shoddy construction and high price tag, Wu assumes money was siphoned off.

WU: (Through Translator) Inspectors probably didn't do their job and builders skimped on the job. As to $8 million, they may have spent, at most, one to $3 million here.

LANGFITT: China's state-owned banks often fund these projects. But if you're a small or a midsized private business, the kind that produce most of the jobs here, good luck getting a loan. Ask Katrina Tong. She exports electric chargers for a company in Shenzhen.

KATRINA TONG: (Through Translator) We think market demand for our products is out there and we have potential, but it's really hard to get financial support. It's so frustrating.

LANGFITT: In fact, the vast majority of small and midsized companies in Shenzhen can't get bank loans. Instead, many turn to private lenders, who charge a loan shark-like interest rates.

TONG: (Through Translator) We feel our business and ideas are very good. But in China, it is really hard to get investment. Investment all goes to big companies.

LANGFITT: China's state-owned banks prefer state-owned companies, in part, because they're less risky. But economist Xu Dingbo says many state firms are inefficient.

DINGBO: You see a lot of nice building, highway and beautiful cities like Beijing and Shanghai. But if you look at the real financial numbers of many Chinese companies, the picture is very bad. It's horrible.

LANGFITT: Xu says the largest 102 state-owned companies had an average return based on assets of about 3.5 percent.

DINGBO: For nearly half of the assets in China, the rate of return is less than depositing the money in the bank. That means we are wasting lots of resources in China now.

(SOUNDBITE OF ARCHIVED SPEECH)

WEN JIABAO: (Through Translator) I do not agree with the argument that China's growth had come to an end after 30 years of reform and opening up.

LANGFITT: This is Wen Jiabao, China's outgoing premier, addressing skeptics at a forum last month. Wen insists China can rebalance its economy by unleashing consumer demand.

(SOUNDBITE OF ARCHIVED SPEECH)

JIABAO: (Through Translator) China is a country with enormous potential and a big domestic market, and we, the Chinese people, have full confidence in our own development.

LANGFITT: Fixing China's economy will require taking on powerful interests, including the state banks and state-owned companies that enjoy monopolies. It's a big challenge and a crucial test. But given the Communist Party's remarkable track record, no one is counting it out. Frank Langfitt, NPR News, Shanghai. Transcript provided by NPR, Copyright NPR.